How To Play The Legalization Of Online Gambling

Delaware's legislature on Wednesday passed a law that would legalize a full range of online gambling within Delaware's boundaries. This marks a significant step after the Justice Department's new legal interpretation on Dec. 23,2011. This law is expected to create a domino effect in the Middle Atlantic region, which is well known for its large-scale gambling competitions.

In order to capitalize on the change that this law is going to bring with it, we have three different avenues to discover: one, companies that provide online gaming solutions are surely going to be the winners; two, Internet gambling companies will also see their revenues surge; and three, the already-famous casino resorts have reacted differently to this news. One group strongly advocates this relaxation and has already shown its keenness to add this dimension to their operations. Their stocks are expected to reap the benefits after this declaration. However, the other group vehemently opposes Internet gambling, stating that it has led to depletion of their profits, and they think Internet gambling is illegal. Their stock prices are expected to decline or remain stagnant, unless they move toward Internet gambling.

Justice Department's Legal Opinion on Internet Gambling

It is important to first understand the legal interpretation that the Justice Department has issued before we can gauge its impact on the casinos and related industries. The announcement came in response to New York and Illinois seeking to use the Internet for lottery sales. The 13-page document dated September 20, 2011, was made available to the public on Dec. 23, which gave a clarification that the Wire Act of 1961 prohibited only Internet sports betting -- the other forms of Internet gambling can be legalized. However, the authority to legalize such a thing vested with the states, and online gambling could only take place within the boundaries of that state -- i.e., the person gambling should be residing within the boundaries of that state.

Online gambling bills have been introduced in different states -- e.g., California, New Jersey, Illinois, New York, etc. However, only Delaware has passed a bill whereby all forms of gambling have been legalized (except sports betting, which is not allowed by The Wire Act of 1961), something that is not found in other states where primarily lottery or online poker has been legalized. The main reason for not legalizing online gambling on a full-fledged scale in all other states is that the authorities want to see how they can effectively curb the downsides that come attached with this legalization, e.g., addiction to gambling, underage gambling, etc. -- some of the objections raised by the people after the new interpretation was announced.

Many critics say that the government has decided to embrace online gambling as it is expected to generate an additional $12 billion of annual revenue in the economy, which means at least $2 billion of annual tax revenue that will help to bridge the budget deficit. Not only that, it will directly create some 10,000 high-tech jobs.

Bricks and Mortar Casino Resorts

Common sense tells us that these resorts will experience a hit in light of this relaxation on Internet gambling. However, the stock trends of most tell us a different story altogether. This is because these companies have wisely chosen to embrace this transition, and have adjusted accordingly to add this dimension to their operations. Many of them started negotiating a partnership with online gaming companies to launch Internet gambling, well before they were given the intrastate license to trade online. These stocks have already experienced growth after the interpretation was made public on Dec. 23, 2011.

It is expected that the larger the operations a firm owns, the more intensely it will embrace online gambling and hence benefit more. One can gauge the size of operations by the number of casinos that a firm has:

Gaming Company

# of US properties

# of foreign Porperties

# of properties with poker rooms

Total # of Poker Tables

Caesers Entertainment

42

13

34

522

MGM Resorts

22

1

16

286

Wynn Resorts

2

2

2

37

Las Vegas Sands

3

3

3

103

Station Casinos

18

0

8

101

Boyd Gaming

17

0

8

189

Penn National Gaming

25

1

9

129

Isle of Capri Gaming

15

1

7

110

Ameristar Casinos

8

0

5

64

Pinnacle Entertainment

7

2

4

43

Potential Winners

CZR is a gaming company that operates casino resorts in multiple continents. Formerly known as Harrah's Entertainment, CZR plans to embrace the new transition fairly quickly. The same was reflected in an interview held with its CEO Gary Loveman, who is enthusiastically looking forward to the opening of a new arena after the five-year-old terrible episode of banning online gambling by federal regulators, which dubbed "Black Friday" by the online poker community. CZR had a rocky IPO and is also having some trouble managing its debt levels. However, the size of its operations globally and its recent partnership with 888 Holdings Plc, an Internet gambling site operator, shows its determination to pull everything out of this opportunity, which has become available after online gambling has been legalized under the World Series of Poker brand.

MGM, through its wholly owned subsidiaries, owns and operates casino resorts that include gaming, hotel, dining, entertainment, and other resort amenities. Having a large amount of debt has not dented the company's reputation as Standard & Poor's recently revised MGM's outlook to positive. Despite showing a loss last year, the firm is enthusiastically waiting for online gambling to become legalized throughout the U.S. Its CEO, Jim Murren, was reported as saying, "We'll be one of the first horses out of the gate when it's approved."

Researchers have estimated that at least $200 million out of a gain of $5 billion from online gambling will go to this giant. MGM recently announced its partnership with Bwin party digital entertainment -- a U.K.-based company -- to offer Internet gambling in the U.S. under the brand of Party Poker, after the wave of legalization initiated.

BYD owns and operates casino resorts in different parts of the U.S. The firm has been actively planning to buckle up for the foreseeable change that the industry is going to experience in the next six to seven months. The firm bought Peninsula Gaming LLC (NASDAQ:PENN) for $1.45 billion this May. The firm earlier, unsuccessfully, tried to acquire Las Vegas-based Station Casinos for $2.45 billion, which liquidated in 2010.

Potential Losers

LVS is a global developer of destination properties that feature accommodation, gaming, entertainment, and retail. The firm has massive operations and market share in Macau, Singapore, and Las Vegas. The firm is believed to have a manageable debt as Standard & Poor's recently upgraded the firm to BB+. Its debt-to-equity is also better as compared to giants like WYNN and MGM. However, the firm's CEO Sheldon Adelson has remained quiet on the issue of online gambling, which gives us no signal regarding the future plans of the business to move toward Internet gambling. History tells us that he has been against Internet gambling. However, as the regulators are taking a lot of time to "think before doing," LVS might strike a strategic partnership. Meanwhile, we take a bearish approach toward this stock.

WYNN develops, owns and operates casino resorts in Las Vegas and Macau. WYNN has shown favorable metrics amid other giants like LVS and MGM, which have had a tough time dealing with debt-related issues. However, WYNN CEO Steve Wynn has dealt with the online gambling opportunity in a way that has confused investors a lot. He signed a deal with PokerStars, the world's biggest online gaming company, on March 24, 2011, and terminated it on April 15, 2011, saying, "There didn't seem to be any interest in the government to enforce restrictions on the game of poker."

However, it is important to state that it took Isai Scheinburg, the founder of PokerStars, a lot of time to convince Wynn to sign the deal under which both companies would have worked together to get the game regulated in the U.S. This means that Wynn had not been interested in this dimension at all. Even though U.S. regulators will take their time to get the online gambling industry regulated, we will suggest a bearish approach toward this stock.

Online Gaming Solution Providers

Online gaming solution companies provide instant games, terminal and game-related services, and Internet applications. In this context, they will definitely experience a high demand as casino companies will seek to quickly entrench their roots in the new legal form of gambling. However, this demand will depend on certain factors that include their scale of operations and expertise, which will eventually decide as to which bricks and mortar casino they end up forming an alliance. This is extremely important given the fact that the law does not allow them to operate on their own, and they can only provide Internet gambling in a partnership with a bricks and mortar casino.

Major Players

PokerStars

PokerStars is the largest online gaming company in the world. The "protagonist" of the Black Friday episode, the firm is trying all the ways to come back to the U.S. after being alleged for illegal processing of payments in April 2011. However, the firm has been smart enough to retain its clients and is still a big player in the European market. If it gets a chance to reemerge in the U.S. market, which is highly improbable, PokerStars is expected to give a considerable return, if not the maximum.

ZNGA develops, markets and operates online social games on the Internet. The firm has recently come up with a social networking service that makes it easier for users to play online games across different mobile models. The developer of Texas Holdem Poker, a famous poker game on Facebook, the firm has a high potential in this restructuring of the Casino Industry. ZNGA recently acquired Marketzero, an online poker tracker company, which has added to its chances of being a winner. The main catalyst to look for is when the firm signs an agreement with a bricks and mortar casino to make online gambling games.

BYI operates in three segments: gaming equipment, gaming operations, and systems. The transition in the industry landscape means that its technology solution providers will have a busy time in future. The firm recently got a license to provide solutions to a casino operator, being one of the first ones in the industry to get one. It is well prepared for the future hike in demand as it acquired Chiligaming in April 2012, which allows it to offer online poker software to casino operators. The stock is recommended as a buy.

IGT is a global gaming company that manufactures and markets gaming equipments and system products like online solutions. The firm's recent acquisition of Entraction, operator of one of the world's largest poker networks, of $100 million and its entitlement to an operating license in Nevada, shows that the firm is ready for the change, which is almost inevitable. The stock must be kept under watch as it will continue to start providing services in late 2012 or early 2013.

Other Players

Scientific Game Corporation (NASDAQ:SGMS) is a global supplier of instant lottery games and games solutions. The stock has already shown improvement and will likely show more given that it gets a contract signed with a casino operator. International Lottery and Totalizer Systems (OTCPK:ITSI), a supplier of computerized wagering systems, is the same.

Isle of Capri Casinos (NASDAQ:ISLE) develops, owns, and operates gaming facilities in the Bahamas, the U.S., and the U.K. Showing back-to-back quarter earnings surprises of 26.7% and 70%, the firm has enough capital in its pockets to finance the changes required to compete in its industry.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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